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Chapter 15 Trade and Policy Reform in Latin America Copyright © 2011 Pearson Addison-Wesley. All rights reserved. Chapter Objectives • Discuss the long-run performance of the economies of Latin America • Examine the origins and extent of Latin America's economic crisis of the 1980s • Discuss the economic reforms of the late 1980s and 1990s Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-2 Introduction: Defining a “Latin American” Economy • A “Latin American” economy is considered “all of the Americas south of the United States” (Webster’s dictionary) • However, Latin America is quite diverse, and one needs to be careful not to overgeneralize Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-3 Population, Income, and Economic Growth • For long stretches of the 20th century, Latin America was one of the fastest-growing regions of the world • From 1900-1960 real GDP per capita grew at similar rates to Europe, U.S., or Asia • The Debt Crisis turned the 1980s into a Lost Decade, as growth was negative, inflation skyrocketed, and poverty increased Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-4 TABLE 15.1 Population and GDP for Latin America and the Caribbean, 2007 Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-5 TABLE 15.1 (continued) Population and GDP for Latin America and the Caribbean, 2007 Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-6 TABLE 15.1 (continued) Population and GDP for Latin America and the Caribbean, 2007 Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-7 Import Substitution Industrialization: Origins and Goals of ISI • Key points about reliance on import substitution industrialization (ISI) policies from the 1930s to the debt crisis of the 1980s: – Raúl Prebisch of ECLA argued that Latin America experienced declining terms of trade (TOT): (index of export prices)/(index of import prices) – In effect, Latin America would be marked by export pessimism—each unit of exports would earn a declining unit of imports – ISI would boost industries that produce substitutes for imported goods Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-8 Criticisms of ISI • Government involvement in production decisions caused a misallocation of resources; not market failures as assumed • Exchange rate overvaluation • Policies were too biased in favor of urban areas • Income inequalities worsened • ISI fostered rent-seeking and corruption Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-9 Macroeconomic Instability and Economic Populism • Latin America has experienced macroeconomic crises over the past 50 years – Crises are often attributed to economic populism and populist policies: political movements using expansionary fiscal and monetary policies without regard of inflation risks, budget deficits, and foreign exchange constraints Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-10 Populism in Latin America: Three Conditions of Populism • Deep dissatisfaction with the status quo (slow growth) • Rejection of the traditional constraints of macro policy • Promises to raise wages while freezing prices and restructuring the economy by expanding domestic production of imported goods Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-11 Stages of Populist Policies • Economic stimulus through government expenditures and printing money • Creation of bottlenecks • Increase in prices and budget deficit • Acceleration of inflation • Pervasive shortages become pervasive • Capital flight and decline in wages • Resort to IMF help Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-12 The Debt Crisis of the 1980s • Causes: Collapse of world oil prices (Mexico particularly affected) and increase in international interest rates in the early 1980s • Longstanding political mismanagement • High rates of lending in 1974–1982 • Let’s analyze these in greater detail… Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-13 Table 15.2 Debt Indicators at the Onset of the Debt Crisis, 1983 Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-14 Responses to the Debt Crisis • U.S. Treasury Secretary James Baker, 1985, tried to organize a renewed lending program by commercial banks through the Baker Plan • U.S. Treasury Secretary Nicolas Brady engineered the Brady Plan in 1989: Latin American countries required to reform their economies to obtain debt relief • Capital flows began to return to Latin America Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-15 Economic Policy Reform and the “Washington Consensus” • In the late 1980s, Latin America launched economic policy reforms – The region adopted a neoliberal model favoring free markets and minimal government intervention in the economy Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-16 TABLE 15.3 Inflation Rates, 1982–1992 Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-17 Three Aspects of Neoliberal Reforms • Implementation of stabilization plans to stop inflation and control budget deficits • Privatization of state-owned enterprises • Protectionist trade policies were abandoned Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-18 Stabilization Policies to Control Inflation • Some Latin American countries adopted the orthodox model of cutting government spending, reforming the tax system, and limiting the creation of new money • Others adopted the heterodox model: same as orthodox model but also included freezing of wages and prices Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-19 TABLE 15.4 Average Tariff Rates, in Percents, Selected Countries Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-20 Structural Reform and Open Trade • Structural reform policies include: - The privatization of government-owned enterprises, deregulation and redesign of the regulatory - Environment of overregulated industries such as financial services, and - Reform of trade policy • Individual countries, especially Chile and Mexico, started negotiating bilateral free trade agreements Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-21 Structural Reform and Open Trade (cont.) • The three main goals of trade reform: - To reduce the anti-export bias of trade policies that favored production for domestic markets over production for foreign markets - To raise the growth rate of productivity - To make consumers better off by lowering the real cost of traded goods Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-22 TABLE 15.5 Openness Indexes, 1985 and 2007 Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-23 Table 15.6 Regional Trade Blocs Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-24 The “Washington Consensus” • Macroeconomic reforms proposed by the consensus: – Avoid large budget deficits – Spend public money on health, education, and basic services – Cut taxes, but tax a wider range of activities and improve collection – Make certain real interest rates are positive; limit the use of preferential rates – Make the exchange rate competitive and credible Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-25 The “Washington Consensus” (cont.) • Microeconomic reforms proposed by the consensus: – Use tariffs instead of quotas, and gradually reduce them – Encourage foreign direct investment – Privatize state enterprises in activities where markets work – Remove the barriers to firm entry and eliminate restrictions on competition – Guarantee the security of property rights Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-26 The Next Generation of Reforms • Neoliberalism is viewed negatively by many Latin American citizens because it has not resulted in stable economies, falling prices, or greater equality • A second generation of reforms are underway to create more inclusionary economic systems • A few Latin American countries, including Mexico and Chile, have become the most open and outward oriented of countries anywhere, but the results elsewhere have been disappointing Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-27 Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 15-28